I was unemployed for a short time earlier this year and I was considering freelancing, independent consulting as well as a salaried position. Given my analytical nature, I wanted to figure out how much I would need to charge in order to replace my salary. I have always been a salaried employee, so I needed to include the costs of taxes and health insurance as well. I wanted to write a blog post about my findings, but had forgotten until I read a recent post by Skellie over at Anywired regarding a Practical Guide to Earning Six Figures. Skellie has a perfectly reasonable post about this, but leaves out normal office costs, and the taxes and insurance that a corporation pays. This is probably because the target audience is probably already freelancing. So, what does it mean to become a freelancer if you are currently a corporate employee?
Basic Work Schedule
Anyone I have talked to in the freelancing or independent consulting crowd has said you should assume you will not be working about 2 months (or 8 weeks) out of the year. As an employee you typically get about one month of paid time off including vacation and sick time. The minimum of an additional month is needed for gaps between jobs. So, that leaves you with 44 weeks of work. In order to make $100,000 of revenue, assuming 40 hours of work per week, you need to bill $56.82 per hour.
That is the minimum you need to bill. You cannot assume you will work more than 40 hours as some time is required for general bookkeeping, marketing and finding your next client. Plus, if you work for a client for more than 40 hours, think of that income as a bonus. There are also a number of expenses that you would not normally incur like office supplies, a new laptop, a desk and other basic office needs. For our purposes, let us assume it will cost $5000 for your new office. Now, your yearly income needs to be $105,000, or $59.66 per hour.
Replacing Your Employer
This is the part that most freelancers do not talk about, replacing the costs that your normal employer pays. So, you have the taxes that the corporation would pay. I will not get into the benefits of a C-Corp, S-Corp or LLC as that is best left to a financial professional. If you are considering freelancing, I highly recommend talking to a financial professional because there are benefits to “incorporating” yourself. First, what are the assumptions that the corporation normally pays? There are the state and federal taxes and medicare costs. There is also health insurance and most likely a 401K plan. Unless you can get health insurance and a 401K from your partner, you really should have both even as a freelancer. Normally, the taxes taken from your gross pay are around 20%. For the 401K (or equivalent IRA), you should be taking about 5% out of your gross income as well.
Health Insurance is the big cost that most people have no clue about. In Pennsylvania, you can find “small group” insurance plans for a family that cost about $1200 per month. If you are an individual, the costs can drop to $250 per month. For our purposes, we are assuming that you need the family insurance plan for a little more than $1200 per month. For an entire year, the insurance would cost you almost $15,000. This increases the gross income to $120,000. Given that there are also unplanned expenses for any endeavor, we want to add the taxes and 401K savings to the gross income. This allows us to plan for these expenses as well as any tax shortfalls you may have. For the additional 25%, the yearly income increases to $145,000 or $82.39 per hour.
So, if you want your (almost) net income to be six figures, you would need to bill a minimum of $82.39 per hour. If you want to have a gross income of six figures you are billing a minimum of $59.66 per hour. Your net income would also drop to approximately $63,750. There are other expenses as well that could appear. You may need training on new technology, or at least some level of education. This is typical a few thousand dollars per year, depending on what you need training in. There are also legal and accounting fees that you will be paying in order to ensure that you are somewhat shielded from liability and you are submitting your taxes appropriately. If you “only” bill $100,000 of income, your net income can drop below $50,000 fairly easily.
Obviously, there are ways to minimize some of these costs. Getting in touch with your local small business association, can provide you with cheaper services from local businesses. Sometimes the SBA can also get you a group rate for the health insurance as well. There are also other personal issues like not working at an office with a team of people, but that is not a financial concern and Skellie could give you better information anyway.
So, do you want to be a freelancer?